Historic preservation projects are designed to protect a community’s heritage often through the expansion and enhancement of historic properties for public use. Community capital is designed to empower a community’s investment in itself through public offerings that are structured to engage a variety of investors. Preservation projects could meet their goals faster and gain additional political and monetary support through the use of community capital raising strategies.
Community investment strategies differ from typical private strategies as they allow investment broadly from community members rather than restricting investment only to the highest net worth individuals or institutions. Community capital does not have to be the only source of capital for a project, but it can have an impact beyond the funds raised.
Community members can be great allies (or in some cases, strong adversaries) to real estate development projects. Restoring or repurposing a historic building is made easier if a developer has both capital and community support. Why not combine the two?
Including community members as investors in projects not only affects the project’s bottom line, but also impacts the level of community acceptance of the proposed purpose and use of the property. With a community capital approach, community members share in the potential return on investment and can become great ambassadors for the project as it wends its way through any approval process, and later as the property opens for its new or improved purpose.
At Cutting Edge, we work to identify, design and build capital raise strategies that meet client goals and strive to involve community stakeholders. Depending on the purpose and scope of the project, community capital raise strategies might include single, or multi-state, direct public offerings, Title III Regulation Crowdfund offerings or larger Regulation A campaigns. Or, a developer or manager can put together a community investment fund that can support various enterprises or projects. These approaches work not only for real estate projects but across a wide range of industries.
Since 2015, a bipartisan coalition of lawmakers has advocated for tax incentives for those who invest in low-income communities, recognizing that the benefits from the economic recovery have largely bypassed those communities. Their efforts were rewarded when their proposed opportunity zone program was included as Subchapter Z of the2017 tax law overhaulthat was passed in December. While Subchapter Z wasn’t specifically tailored to community capital, it offers tax incentives that will apply to some kinds of community investment funds.
First, here’s how the new law works: A taxpayer with capital gains can defer capital gains tax if they sell their appreciated assets and, within six months, roll over the profits into a “qualified opportunity fund.”
But it gets better. Investors in the qualified opportunity fund who hold their investment for at least 5 years will have their basis bumped up by 10% of the deferred gain (thus reducing their capital gains tax), and by another 5% if they hold it for 7 years. In 2026, there will be a realization event (in which investors are taxed on the other 85% of the original profit invested in the fund, assuming the investment has been held for 7 years). But if they continue to hold their investment for at least 10 years, their basis is bumped up to the market value of their investment, which means any further capital gains tax is eliminated completely.
A qualified opportunity fund is a partnership or corporation with at least 90% of its assets consisting of qualified opportunity zone property (and acquired after 12/31/2017), which can include:
Equity interests in a corporation or partnership that is an opportunity zone business (and issued directly by the corporation or partnership, not acquired in secondary sales); or
Tangible property (real or personal) located in the opportunity zone that is either first used by the fund or is substantially improved by the fund (the latter meaning that additions to its basis exceed its original basis).
A business is an opportunity zone business if:
Substantially all of its tangible property is located in the opportunity zone;
At least 50% of its gross income is derived from operations in the opportunity zone;
A substantial portion of its intangible property is used in its operations in the opportunity zone; and
Securities comprise less than 5% of its total assets by tax basis.
While this new law provides tax incentives to invest in funds that serve low-income communities, it does not provide any new strategies under the securities laws. It is probably inevitable that the vast majority of qualified opportunity funds will be open to accredited investors only, like nearly all private funds.
However, there are at least three strategies that allow a qualified opportunity fund to be open to its entire community, including non-accredited investors:
Real estate fund: A fund whose primary business is investing in real estate and 90% of whose assets consist of real estate in an opportunity zone will be a qualified opportunity fund and will be exempt from the burdensome regulations of the Investment Company Act of 1940 (the “1940 Act”), which paves the way for the fund to raise capital via a direct public offering – making it a true community investment fund.
Small business holding company: This type of fund is exempt from the 1940 Act if most of its assets comprise controlled or majority-owned subsidiaries – the idea being that the fund is in whatever business its subsidiaries are in, rather than in the securities investment business. Again, if 90% of its holdings are businesses in opportunity zones, it will also be a qualified opportunity fund.
Intrastate fund: A closed-end fund of up to $10 million, all of whose investors reside in the same state, is eligible to seek an exemptive order from the SEC that allows it to raise community capital via a direct public offering and while avoiding all or most of the 1940 Act’s regulations. Such a fund could invest in either business or real estate in opportunity zones and thereby also become a qualified opportunity fund.
With any of these strategies, a community-scale fund can open up the opportunity for community ownership of community assets, with everyone able to participate on a level playing field, and everyone able to reap the profits from local ventures.
It should be noted that governors of each state had until late March to designate low-income census tracts as opportunity zones, but some have asked for a 30-day extension. However, only 25% of the low-income communities in each state may actually be designated as opportunity zones. It remains to be seen which communities will actually win that designation.
But community investment funds can be offered to the public in any community anywhere in the U.S. At Cutting Edge Capital we believe community investment funds are an effective way to significantly move the needle toward a more inclusive, democratic and decentralized economy.
If you would like to see this happen in your community, here are some steps you can take:
Look at this map, which shows the census tracts that may be eligible for designation as an opportunity zone.
If your community includes eligible census tracts, write to your governor, asking him or her to designate those tracts in your community as an opportunity zone.
If you would like to see community investment funds serve your community, fill out our intake formto make an appointment with us to explore the kinds of funds that can be offered in your community.
Often at conferences I talk about the different ways to utilize community to raise capital. But this time I wanted to focus on how community capital strategies are part of social and environmental justice solutions and to discuss why who is allowed to invest matters. In other words, I wanted to discuss why the impact of community capital is about much more than just the money. Here are my notes from my remarks at the conference:
We at Cutting Edge Capital like to call our solutions “community capital” strategies. What are community capital strategies? Investment offerings that are open to both high net worth individuals and institutions, and to community (non-accredited or retail) investors.
The current model for capital raising, even in many social and environmental justice enterprises, is to reach out to the wealthiest accredited investors in our networks when capital is needed. That model is not wrong, but choosing only that approach means that enterprises are missing the opportunity to engage all supporters (regardless of their wealth) and missing out on the impacts that flow from doing so.
Community capital strategies democratize our economy in a variety of ways. Here are some of the impacts community capital offerings can have on investors, enterprises, and the broader community:
Community Investors. Community capital offerings allow everyone to invest in alignment with their values. Currently, non-accredited or community investors are not permitted to invest in most private enterprises, including social and environmental impact companies. Most people are limited to putting investment dollars into Wall Street offerings: publicly traded stocks, mutual funds, and money market accounts. Offerings that are open to community allow those members to invest in businesses, cooperatives, nonprofits or other enterprises that offer innovative solutions, are committed to good environmental practices, and/or are supporting social justice missions. It is the practice of so many impact organizations to reach out to community to help shape their missions and the foci of their work. We need to ask ourselves: why do we leave those community members out of the investment opportunity when it is time to implement the ideas the community helps define?
Entrepreneurs/Enterprises. How do we increase equity and access to capital for women and people of color? This is a question we in the impact capital space have been trying address from the start. To date, much of the focus has been on getting more women and people of color in front of existing traditional, institutional, and accredited sources of capital. However, community capital is an alternative to traditional capital that can organically level the playing field. When a broader segment of community is invited to invest, those investors will be more diverse than most existing high net worth investors and funding institutions. Entrepreneurs that receive funding will likely reflect the community that is investing in them. Community members will choose entrepreneurs that speak their language (literally and figuratively), echo their values, and are committed to impacts that solve problems in their community. In other words, if more women and people of color are investing, more women and people of color are likely to receive funding.
Community. When community members invest in local businesses those enterprises can use that capital to thrive and grow — creating jobs and a more vibrant local economy. Any returns generated by those businesses go back to local investors. This creates a cycle of community investment, impact, wealth creation and (hopefully) community reinvestment. The process is one of reinvestment and does not extract resources out of the local economy.
So, how do we do we achieve this? Investors (both accredited and community) need to search out and ask that investment offerings be open to community investors. Enterprises and entrepreneurs (and supporting organizations) need to explore how to make investment opportunities open to community investors.
Community capital is investment sourced from a broad spectrum of a community, including both wealthy and non-wealthy investors. While typically defined by geography (like a city or county), it can also be based on a common interest (like education or biodynamics).
Why is Community Capital Better for My Venture?
Better terms: Your community invests in you to help you succeed, not just to maximize their profit.
Deeper connection with your community: Your investors can be great ambassadors, and sometimes customers.
Why is Community Capital Better for My Community?
Keep wealth circulating in your community: Through a cycle of investment, growth, returns, and reinvestment, you can help your community build wealth sustainably.
Democratize the economy: You can level the playing field for wealthy and non-wealthy investors alike, and help narrow the wealth gap.
How Can I Raise Community Capital?
Directly, using a direct public offering. This approach offers maximum control over the terms. And engaging your community directly has non-financial benefits.
Indirectly, from a community investment fund, which raises community capital and invests in community ventures. For entrepreneurs, this approach can be easier and quicker. For investors, it offers diversification and efficiency.
What Types of Community Investment Funds Are There?
Charitable loan funds: Some (though not all) nonprofit lenders raise community capital via direct public offerings. Examples include NCCLF and RSF Social Finance.
Diversified business funds: This type of fund supplements another primary business and makes equity or other types of investments, while sharing profits with investors.
Real estate funds: While not a source of funding for ventures, a fund that deploys community capital into real estate can be a key revitalization tool.
An Oregon real estate company and CEC client, Guerrilla Development, is focused on “creating inventive and experimental projects that use both hemispheres of the brain.” Coincidentally, earlier this month they have been busy engaging both “hemispheres” of investors: accredited investors (a.k.a. wealthy individuals) and non-accredited investors (a.k.a. the rest of us). They are using one of the newest legal strategies for ventures to “crowdfund” investment capital, Regulation A, through which they are offering $1.5 million of preferred equity in the Fair-Haired Dumbbell, an office building with ground floor retail in Portland, Oregon. The offering is open to residents of California, Oregon, Washington, Massachusetts, Virginia, and the District of Columbia. If you’re curious about Regulation A offerings, check out their campaign video for a great overview:
While the idea of raising capital from the “crowd” is catching on around the country with private enterprises seeking growth capital, the Guerrilla Development offering is different from other offerings in that it is part of a broader trend to use today’s investment crowdfunding tools for economic and community development purposes—specifically, downtown revitalization.
This approach marks a change from the way communities have typically sought funds for their improvement: through applying for state and federal redevelopment grants. This significant departure from the familiar approach presents a number of advantages for community-based ventures. For one, it allows for greater flexibility in the use of funds, which are often tightly regulated by grantmakers to specific types of community development projects. In the grant-driven approach, if the project or program doesn’t jive with the rigorous criteria of the grantmaker, there’s a good chance it will never see the light of day. Secondly, crowdfunding opens up a range of new possibilities for communities self-funding their own development. Now, rather than waiting for the state or federal government coming to the rescue of America’s urban cores and downtowns, communities can be empowered to raise their own capital to get projects done using these new tools.
We are working with other groups that are using Direct Public Offerings, or DPOs, to raise capital for downtown revitalization projects. As an example, one of the groups we are working with intends to raise $4.5 million for a real estate investment fund for the purpose of a major overhaul of downtown Fresno, through the purchase and rehabilitation of a number of properties for retail and other uses. Fresno, California, if you don’t already know, sits in one of the most productive agriculture regions on earth, and yet has some of the highest levels of poverty in California. Decades of disinvestment have led to a ghost town-like status in downtown Fresno, in sharp contrast to the abundant agriculture lands outside of the city. Through the use of a DPO, the group will give Fresno residents a chance to invest in the underlying real estate at the center of the revitalization plan, and be a part of the city’s success. The arrangement will ensure that the fund will never take on debt (which goes to the safety of the investments) and will be marketed specifically to local investors. Not having just one or two wealthy investors will allow the manager to make decisions based on the need for the revitalization of the area, without the typical shareholder primacy pressures. The offering is also devoid of the typical wiggle room that real estate developers typically add into their offerings that allows them to change the direction of the plan once it is funded.
Another group we’re working with, Our Katahdin, takes a broader approach to downtown revitalization, targeting the Kathadin region of Maine, which includes both small town and rural geographies. Seeing an opportunity to allow Maine residents to invest in the region’s development, this non-profit loan fund will cycle in capital from Maine residents through a DPO, before either loaning it out at a slightly higher interest rate to qualified ventures for their growth and development, or actually purchasing land for the non-profit to develop. In the process, everyone will benefit: Maine entrepreneurs will benefit from the access to capital; Maine investors (of the lending variety) will benefit from a modest return on investment; the region and its communities will benefit from enhanced economic activity; and the non-profit loan fund will benefit from the revenues for making it all happen.
We’re also excited to share that we’re in conversation with another real estate group, a non-profit Community Development Corporation in Rhode Island, which soon plans to pursue an innovative approach to real estate development in the state. Their approach centers on a public-private partnership with local municipalities to co-fund both the DPO and, if all goes according to plan, real estate development projects in Rhode Island’s distressed urban cores. They propose a fundamental rethink of housing development, bringing together spaces for living, co-working, and education, while also focusing on job creation, community revitalization, and “smart” growth in low to middle income neighborhoods. They, too, plan to use a DPO to engage a wide range of community stakeholders—and shareholders—in the success of the project.
We find a lot to like about this new trend toward greater democratization of investment in revitalization. Not only does it serve as a practical way to access capital for impactful projects that can breathe life into towns and urban cores, but it also serves to empower communities to take charge of their futures. When communities invest in themselves through local ventures, everybody wins.
We recently read The Middle-Class Squeeze, an article that reminds us why we do what we do. The 2,500-word piece by British journalist Charles Moore appeared in the Wall Street Journal on September 25, as its “Saturday Essay,” a remarkable fact given that the article touches on issues that are antithetical to what the publication covers.
The article takes seriously a few of the prognostications of political philosopher Karl Marx. You don’t need to be a regular reader of the Wall Street Journal or even know much about economics to know that the name Karl Marx is most notable by its absence in mainstream economic discourse. Indeed, mainstream economic thinkers have spent the better part of the past century refuting, debunking, and otherwise turning Marx into the great bugaboo of global capitalism. Mr. Moore himself gets on the bandwagon, saying that Marx’s prescriptions were mostly wrong, and that Marx did not understand markets or respect political institutions. But, unlike some other economic commentators, Mr. Moore differentiates himself by his more tolerant views of Marx, and in this article draws upon the thinking of Marx to explain the predicament of a middle class that is rapidly losing ground against prosperity and stability indicators, resulting in a radically unequal society of “haves,” “have lesses,” and “have nots.”
While we at Cutting Edge Capital wouldn’t call ourselves Marxists, we certainly agree with a few of Mr. Moore’s points about “the disproportionate power of the ownership of capital,” as he puts it. Yes, the owners of capital decide where money goes, at the policy-making level and on the level of our public and private capital markets. The people who sell only their labor, or their idea in the case of entrepreneurs, lack that power, making it hard for society to be shaped by their interests. We do also agree with his call to put this balance right to avoid becoming the worst kind of society imagined by Marx, one in which the modern state becomes “but a committee for managing the common affairs of the bourgeoisie,” or, more commonly, the 1 percent.
The subtitle of Mr. Moore’s article reads: “If Western countries want to disprove the dire forecasts of Karl Marx, we must think creatively about how to make the middle class more prosperous and secure.” We take pride in knowing that our work is one part of the solution—a capital market that provides the ability for a business or nonprofit to raise investment capital from all of its stakeholders, from friends and family to customers and supporters, wealthy or not, and for those individuals to become empowered through ownership in a just and democratic new economy.